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My PFS - Technical news - 10/10/17

Personal Finance Society news update from the 27th September to 10th October 2017.

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Taxation and trusts

Investments

Pensions

TAXATION AND TRUSTS

FCA launches service to help asset management businesses get authorised

(AF2, JO3)

Following publication of its final report into the asset management sector, the Financial Conduct Authority (FCA) has launched a service which will help asset management businesses get authorised.

The hub, which is expected to launch this month, is intended to help new entrants to the market navigate the complicated web of regulation.

“We know some of those businesses find it difficult to navigate regulation,” said Megan Butler, executive director of supervision - investment, wholesale and specialist at the FCA.

Last year the Regulator approved the launch of 204 investment firms.

The hub will offer start-ups, pre-application meetings and dedicated case officers, as well as a ‘user friendly’ web portal.

The launch follows the successful launch of a similar project at the Prudential Regulation Authority for banking start-ups.

Changes to PAYE settlement agreements

(AF1, AF2, RO3, JO3)

As the deadline for paying tax on PAYE settlement agreements (PSAs) approaches HMRC has announced improvements to its PSAs but, unfortunately, they won’t take effect until April 2018. This effectively means they won’t affect 2016/2017 PSAs for which the related tax and NI (Class 1B) payment is due no later than 19 October 2017 (22 October if payment is by electronic means) – together with Form PSA1.

What changes are planned?

In April 2018 HMRC plans to:

  • provide an online digital service for submitting PSA reports and paying the related tax and NI
  • remove the need for an annual upfront-PSA agreement
  • improve its guidance for employers

Under the current rules it is possible to account for tax and NI on small or irregular perks which are provided to employees using a PSA provided the employer has obtained agreement from HMRC by 6 July following the end of the tax year in which the perks were provided. In future, this will not be necessary as it will be possible for employers to decide what they wish to report which will save administration and provide more time to do the calculations.

And, developing a digital solution, which will be a largely automated process, will no doubt make things quicker.

Growing businesses to benefit from expert tax support

(AF2, JO3)

HMRC has launched a new service to directly help mid-sized businesses as they expand and grow. The service is known as the Growth Support Service which will involve HMRC tax experts offering dedicated support tailored to the customer’s needs.

This could include:

  • helping with tax queries about their growing business
  • supplying accurate information and co-ordinating technical expertise from across HMRC
  • supporting them to get their tax right first time and access relevant incentives or reliefs

It would appear that there are around 170,000 mid-sized businesses registered in the UK and many of these are undergoing significant growth, so the ability to seek expert help from HMRC should be invaluable.

2016/17 self-assessment tax calculator: Fix is due to be in place by 23 October 2017

(AF1, AF2, RO3, JO3)

A few months back it transpired that software issues in HMRC’s online filing system were causing many taxpayers to overpay tax.

HMRC recently implemented some changes to accommodate the order of income tax reliefs and allowances and has said that an updated version of the 2016/17 tax calculator is due to be in place by Monday 23 October 2017.  This fix is required to correct calculations of the income tax liability for certain combinations of income which include interest and dividends. However, there is still an issue in cases where capital gains and losses are to be reported, although where there is no overall gain or loss HMRC has issued a workaround which should ensure that no additional tax will be due.

This comes as good news and, given that the date of implementation of the revised calculator is only a couple of weeks away, it may be advisable for many to wait until then to file their self-assessment return.

INVESTMENT PLANNING

National Savings & Investments closes the Children’s Bond

(AF4, FA7, LP2, RO2)

When National Savings & Investments (NS&I) announced the launch of their new Junior ISA, they said that the Children’s Bond would be closed to new sales from September 2017. No date was specified.

NS&I have now confirmed that the latest issue (36), paying 2.00% (tax-fee), fixed for 5 years, was withdrawn from 24 September. NS&I regard the JISA as an effective alternative, even though it is a variable rate product (currently also paying 2%), rather than a fixed rate. 

When existing Children’s Bonds reach maturity, there will be no roll over to a new Bond available. Instead NS&I says it “will contact customers about a month before each Bond matures to let them know what the options are at that time”.

Third quarter investment returns

(AF4, FA7, LP2, RO2)

The third quarter of 2017 is over, with most markets posting small positive returns for the three months. 

Like the second quarter, politics dominated much of the news. The three months saw strong hints from the US, UK and Eurozone central banks that monetary conditions will be tightened, but market reactions were generally limited: they have heard that story before (especially from Mark Carney). As the table below shows, movements were limited:

 

30/6/2017

29/09/2017

Change

 

FTSE 100

7,312.72

7,372.76

0.82%

FTSE 250

19,340.15

19,874.82

2.76%

FTSE 350 Higher Yield

3,768.50

3,771.38

0.08%

FTSE 350 Lower Yield

3,953.53

4,046.55

2.35%

FTSE All-Share

4,002.18

4,049.89

1.19%

S&P 500

2,423.41

2,519.36

3.96%

Euro Stoxx 50 (€)

3,441.88

3,594.85

4.44%

Nikkei 225

18,909.26

20,356.28

7.65%

Shanghai Composite

3,222.60

3,348.94

3.92%

MSCI Emerg Markets (£)

1,455.96

1,508.53

3.61%

UK Bank base rate

0.25%

0.25%

 

US Fed funds rate

1.00%-1.25%

1.00%-1.25%

 

ECB base rate

0.00%

0.00%

 

2 yr UK Gilt yield

0.37%

0.54%

 

10 yr UK Gilt yield

1.33%

1.41%

 

2 yr US T-bond yield

1.38%

1.46%

 

10 yr US T-bond yield

2.28%

2.32%

 

2 yr German Bund Yield

-0.57%

-0.70%

 

10 yr German Bund Yield

0.47%

0.47%

 

£/$

1.2990

1.3417

3.29%

£/€

1.1389

1.1349

-0.35%

£/¥

145.9505

151.0230

3.48%

Brent Crude ($)

48.99

56.69

15.72%

Gold ($)

1,242.25

1,283.10

3.29%

Iron Ore ($)

63.00

61.35

-2.62%

Copper ($)

5,954.50

6,503.00

9.21%

A few points to note from this table are:

  • The FTSE 100 traded in a range between 7,542 (8 August) and 7,215 (15 September). Its performance over the last six months has also been virtually flat, while since the start of the year the Footsie is up 3.2%.
  • The FTSE 250, regarded as a better yardstick for UK plc (although still with about a 50% weighting of overseas revenues), marginally outperformed its large cap counterpart. The FTSE 250 breached 20,000 for the first time in May, but in the third quarter it could not regain that territory. 
  • The US market performed better than the UK, ending the quarter at an all-time high as hopes of tax cuts replaced North Korean concerns. However, for UK investors the dollar again worked against them as it fell 3.2% against sterling over the period. The demise of the dollar has been one of the themes of 2017, even though the Federal Reserve is the only major central bank to have started raising interest rates.
  • Against the backdrop of the Eurozone’s continued monetary stimulus and returning growth, continental stock markets posted a positive return. Angela Merkel’s less than resounding victory in the German election had little effect at the end of the quarter.
  • Bond yields in the UK and USA edged upwards over the quarter, thanks to rumblings from their respective central banks. In the Eurozone rates fell at the short end as the first rate increase remains distant, although QE is likely to be phased down soon.
  • Commodities had a mixed quarter, with gold benefiting little from the dollar’s weakness and US/North Korea sabre rattling. The most notable change was in the price of Brent Crude, which bounced back above $50 as OPEC’s production limits appeared to be biting.

As ever, a look at the figures across a quarter serve as a reminder of just how much day-to-day noise can hide what is – or is not – happening to investment returns.

PENSIONS

IHT arising on pension transfers by people in serious ill health

(AF3, FA2, JO5, RO4, RO8)

In cases where an individual transfers from one pension scheme to another and dies within 2 years of the transfer, HMRC takes the view that, in certain cases, the pension transfer may have given rise to a lifetime transfer for IHT purposes.

In essence, this could be a problem where:-

  • the individual dies within 2 years of making the transfer
  • at the time of transfer, the member knew he/she was in serious ill health and
  • it is not possible to demonstrate that, in making the transfer, the scheme member had no donative intent to others

If it is possible to show that there was no donative intent, the defence in section 10 IHTA 1984 will apply (no intention to confer a gratuitous benefit). This, for example, would be the case if the member was clearly only acting for himself and so immediately encashed the plan following transfer or had in place a plan for a regular systematic encashment.  The Staveley case (on which we understood HMRC intend to make an appeal) is an indication of HMRC’s resolve to only allow the section 10 defence in very specific cases.

HMRC will collect information on “vulnerable” pension transfers via the form IHT 409 – the pensions supplement to the Estate Return on death (IHT 400).  Not everyone will complete an IHT 400. For less complicated estates, which are termed “Excepted Estates” (assets of less than £1 million which pass mainly to a spouse/civil partner or charity), the legal personal representatives (LPRS) can complete the short form IHT 205.  However, if an “offending” pension transfer is involved, the LPRs will need to switch over to using the longer form IHT 400.

For people who transfer at an age when they can draw benefits, the process for calculating the IHT transfer of value has, in the past, been complex.  This involved determining the value of the pension scheme rights that the scheme member has the ability to give away and deducting the value of retained rights to which he/she is entitled immediately before death.  This would typically be the right to the PCLS and the present value of any guaranteed annuity.  Assumptions need to be made for future investment growth and the discount issues that arise with the purchase of such a financial product for notional purchasers.

Fortunately, the days of some of these complications may now be numbered.

In cases where an individual transfers to a pension plan that offers flexible access and that individual is aged 55 or over, we understand that HMRC will now be open to a valuation of retained rights on flexi-access principles. So, for example, the retained rights of an individual will be the entitlement to the PCLS and the residual encashment of the balance of the fund after income tax.  This will, we believe, considerably reduce the likely transfer of value in many of these cases and so, even if clients are caught, transfers of value are more likely to fall within the available nil rate band.

Example - Oliver

Oliver aged 61 makes a pension transfer with a CETV of £1 million.  At the time he makes the transfer he knows that he is suffering from pancreatic cancer and he has a life expectancy of one year.  He unfortunately dies 8 months later having not encashed any of his pension fund.

Oliver’s LPRS will need to report the transfer in Boxes 17-21 of the form IHT 409.  It is extremely likely that HMRC will take the view that an IHT transfer of value arose when Oliver made the pension transfer.

Let’s say that the value of rights before the transfer (taking account of assumed investment growth and appropriately discounted) that is agreed is £950,000.

The net transfer of value will need to take account of retained benefits.  On the basis that Oliver had other taxable income on his death of £100,000 these would be calculated as follows:

PCLS - £250,000

Remaining fund - £750,000

Tax - £335,000

£415,000

Value of retained rights - £665,000

The transfer of value for IHT purposes will therefore be £285,000 (£950,000 less £665,000).  Indeed as this is a chargeable lifetime transfer (CLT), annual exemptions of up to £6,000 may be available to reduce the value of the CLT still further.

If Oliver had predeceased his wife and had not made any CLTs/failed PETs in the last 7 years, all of this notional chargeable lifetime transfer will fall within his nil rate band and so no immediate IHT will be payable.  It will, however, mean that there will be less of a transferable nil rate band available for his widow.

Of course, in the old days the value of retained benefits could, in appropriate cases, be treated as a lifetime transfer of value immediately before death under the “omission to exercise a right rule” in section 3(3) IHT Act 1984.  As regards uncrystallised pension rights that rule was abolished by amendments to the IHT legislation in the Finance Act 2011.  Furthermore, it no longer applies to crystallised pension rights following changes made in the Finance Act 2016.

Using the 45% tax credit on payment of lump sum pension death benefits

(AF3, FA2, JO5, RO4, RO8)

As is well known, in the case of a member of a pension scheme dying aged 75 or over and a lump sum being paid to a personal discretionary/flexible trust (such as a by-pass trust), a 45% SLSDBC income tax charge will arise. On later payment of some or all of this amount to a beneficiary, the beneficiary will be taxed on the grossed-up amount but be entitled to a credit for tax previously suffered by the trustees.  Two issues arise out of this:-

  • Where the individual has a tax liability on other income that is less than the tax credit on the payment out of the trust, can the excess tax suffered be recovered from HMRC?
  • Where a payment is made out of a trust to a beneficiary, how is that payment attributed to the earlier lump sum payment from the pension scheme? This will be relevant where the lump sum has grown in value or other payments have also been made to the trust.

We now address these issues in more detail.

  • Reclaiming the 45% tax deduction

Section 21 Finance Act (No. 2) 2015 amended section 206 of the Finance Act 2004 to deal with cases where a lump sum is paid to a non-qualifying person (such as trustees) from a registered pension scheme and that lump sum attracts a 45% tax charge, and a subsequent payment is made to a beneficiary.  It provides as follows:-

the amount received by the beneficiary, together with so much of the tax charged under this section on the lump sum as is attributable to the amount received by the beneficiary, is income of the beneficiary for income tax purposes but the beneficiary may claim to deduct that much of that tax from the income tax charged on the beneficiary's total income for the tax year in which the payment is made to the beneficiary.’

Further explanation on the interpretation of this section is given in part 3 of Pension Flexibility in Pension Schemes Newsletter 77.  Here it states that:

‘the individual will be able to set off the tax paid on the lump sum death benefit by the Scheme Administrator (or a proportion of it, where the trust payment is funded by only part of the lump sum death benefit the trustees received) against the tax due on this trust payment. This may lead to a refund of tax.’

Does this mean that the payment (grossed up by 45%) from the trust will be treated as part of the individual’s total income for that year so that some of the deemed 45% tax payment would be recoverable if the individual does not pay tax at 45% on all of the payment from the trust and the tax on other income in that year?  Or is any tax that is “recoverable” limited to the tax the individual pays on other income in that tax year?

Let’s take an example.  Assume that in 2017/18 an individual has other taxable income of £10,000 on which he has a £2,000 tax charge.  Say he receives £10,000 from a pension scheme trust on which the 45% SLSDBC had been paid on receipt by the trustees.

The £10,000 is treated as a grossed-up payment of £18,182 to the individual and so is treated as having suffered tax of £8,182.

The individual’s actual tax bill on the grossed-up £18,182 is £3,636.  Therefore there is overpaid tax of £4,546.

The question is:-

  • can he offset £2,000 of this £4,546 against the tax on his other income and the balance, £2,546 against the deemed tax paid on the distribution from the trust?  This would mean he could recover £4,546 (assuming he has already settled the £2,000 basic rate tax charge on the other income) or
  • can he only offset £2,000 of £4,546 against the tax paid on the other income in that tax year?

HMRC has confirmed to us that section 206(8) Finance Act 2004 requires the beneficiary to include both the lump sum received and the tax attributable as pension income – so both elements are part of total income.  On the basis that the individual would declare £18,182 as pension income and tax previously paid of £8,182, there is no requirement that any resulting overpayment of tax should be restricted and therefore, in the above example, it would be possible to obtain a repayment of tax of the full £4,546 (assuming the tax on the other income had been paid).

  • Attribution of payments made to beneficiaries

In what way is any payment made to a beneficiary attributed to the original payment from the Scheme Administrator to the trustees?

For example, say a member died aged 76 and lump sum death benefits of £100,000 were payable.  If these were paid to the trustees of a personal trust, the Scheme Administrator would deduct tax of £45,000 and pay that to HMRC leaving them with £55,000 to pay to the trustees.  Let’s say the trustees invested the £55,000 and after 5 years the trust fund is worth £85,000, having enjoyed capital growth and accumulated income.  The trustees then make a capital distribution of £10,000 to a beneficiary.  How much of that payment is attributed to the original £55,000 payment?

It would seem to us that there are 2 possibilities, as follows:-

  • The whole of the payment to the beneficiary is attributed to the original payment to the trustees.  So, in this case, the beneficiary would be treated as having received a grossed-up payment of £18,182 on which tax of £8,182 had been suffered.  This would give the beneficiary a tax credit of £8,182.
  • A proportionate part of the payment to the beneficiary is attributed to the original payment to the trustees and a part to capital growth.

So, in this situation £6,471 (55/85 of £10,000) would be treated as being attributable to the original payment with £3,529 representing the capital growth.  This would give the beneficiary a tax credit of £5,294 on the overall payment.

In this case, HMRC has confirmed to us that it is up to the trustees to decide how to attribute the lump sum death benefit to beneficiaries within the trust rules.  Section 206(8)(b) Finance Act 2004 states that payment of any part of that lump sum received by the beneficiary is treated as pension income. The treatment therefore can apply only to the part of any payment attributable to that original amount of lump sum or, it seems, the whole payment.  The trustees can make this decision.

 

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